HMRC KAI Directorate have developed two tests, reserve estimation and reserve development. They will apply them and produce lists of possible cases for further risk assessment. The following descriptions are in broad terms.

Reserve estimation

This uses a combination of statistical techniques to establish a benchmark for the level of provisions a company would have if it completely followed the average result across the general insurance market and tests this against the result for the particular company. However, because companies vary greatly by reference to the type and risk of business that they take on, this simple comparison would not be effective. A second test is then applied to determine whether from one year to the next the result of the first test, the provisioning position relative to the ‘whole market’, has changed significantly.

The approach does not therefore interest itself in the absolute question of how far the company lies from the benchmark, but rather on whether this position relative to benchmark changes significantly from one year to the next. This is designed to compensate both for the effect of the insurance cycle and for the inherent differences in company characteristics.

Reserve development

This test is designed to complement the reserve estimation test by examining whether the company has a history of over provisioning compared with the market as a whole. The test averages out the last five years of a company’s provisioning variance by calculating the adjustment to the technical provisions for each company as a percentage of the provision carried forward into that year. It then compares this to the average result for the general insurance market as a whole.